After the results of the frankly disappointing Basel 111 banking regulation accord were released late on Sunday evening we saw equity rallies pretty much around the world. The Dow Jones Industrial Average rose by 81 points to 10544 and the UK FTSE 100 rose by 63 points to 5565. For the UK equity market this means that the FTSE 100 has rallied by 9.7% since its recent intra-day low of 5071 on the 25th August. Of course we have a large banking sector and just to give an example of the performance one of them Lloyds Banking Group had a low of 66p on the 25th August and closed at 78p yesterday for a rally of 18% in less than three weeks. Of course a marginal price does not necessarily indicate the ability to sell a large part of a bank but UK taxpayers at least have an asset that is currently valued more highly than before.
Japan’s Prime Minister survives a challenge
One market which did not follow the rallies is Japan as the Nikkei 225 equity index dropped by 22 points to 9299. Part of the reason for this decoupling is that there was a vote on who will be Prime Minister in Japan today. As to whether equity markets were unsettled by the fact that Naoto Kan kept his position or by the fact that Mr.Ozawa who had been embroiled in a corruption scandal not so long ago felt able to stand at all I am not so sure. One subject which reared its head very quickly after the victory was the strength of the Yen which rose to a fifteen year high at 83.25 versus the US dollar on the announcement. This is partly a function of US dollar weakness as the exchange rate versus the Euro at 107.24 is not quite as strong. Returning to the Nikkei 225 it is now some 1245 points lower than the Dow Jones.
Most countries would be grateful for strength against the US dollar as the fact that many commodities are priced in US dollars means that many import prices which are often input prices as well are reduced by such a move. However for Japan this is something more like a curates egg as she is mired in disinflation which the Bank of Japan is trying to end.
European Central Bank buys more peripheral debt
After all the rumours last week that the Securities Markets Programme was back in action, today we have confirmation that it was. For those unaware of the programme it is the one which the ECB uses to buy peripheral nations debt in the euro zone. Actually this should be against its constitution but a ruse was used to get round this by declaring that the markets were in a type of disequilibrium which the ECB was stepping in to help. After the shock and awe announcement of May 10th the ECB bought some 16.5 billion Euros worth in a week but over time it has scaled down its buying and up until last week seemed to have pretty much stopped at a total of 61 billion Euros.
The European Central Bank bought 237 million Euros of government bonds last week which is the biggest amount since the middle of August. Although this is not announced officially these purchases would have been of Greek, Portuguese and Irish bonds as the extra premium these so-called peripheral euro zone markets have to pay in interest rates over Germany rose because of deteriorating sentiment. The extra yield spread over Germany that Portugal and Ireland have had to pay in interest rates for 10-year bonds hit record levels last week and the reasons for this were documented in my articles of the 7th and 8th of September and I first introduced the Securities Markets Programme on the 10th May.
In the short-term the buying appears to have helped calm things down a little as Portuguese,Irish and Greek ten-year government bond yields closed at 5.77%,5.85% and 11.58% last night respectively which are improvements on the recent highs. However the ECB’s figures are only up to last Friday so they may have been buying again. Each of these three countries face serious problems which will mean that the issue is unlikely to go away for long. On this subject the sovereign wealth fund of Norway has rather gratuitously announced it had been buying Greek government bonds. I say gratuitously because it has a lot of money due to Norway’s vast gas and oil reserves and no doubt buys plenty of assets but it does not usually go to the trouble of advertising this. So it looks as though some form of political/official spinning is going on for Greece which does coincide with her politicians going on a roadshow to try to sell her bonds. There is an auction of 6 month Treasury Bills today which if the roadshow is going to have any effect will need to go well so perhaps we should expect that as it would appear that we may well be being primed for this.
Central banks: The Federal Reserve
On the subject of central banks buying sovereign debt we also find that the Federal Reserve in the US is stepping up its purchases of government debt under its QE-lite programme. After buying some 18 billions dollars worth in its first month it plans to buy some 27 billion in its second. This leads me to two think of two themes.
1. What happened to central banks exit strategies?
2.Central banks are becoming entangled in almost every market which cannot be healthy in the long run and may not be in the short run either.
UK Inflation issues continue
Last week saw the publication of producer price figures for the UK. These are useful because they give us an idea of inflationary pressures that are in the system but have not yet emerged into prices in the shops. According to the Office for National Statistics they were as follows. Output price ‘factory gate’ annual inflation for all manufactured products rose 4.7 per cent in August and input price annual inflation rose 8.1 per cent in August compared to a rise of 10.8 per cent in July.
So whilst the figures have reduced a little from the recent highs we still have a problem particularly with input price inflation which is way above any of our other inflation indices
Consumer Price Index
The figures released this morning show our inflation rate as measured by CPI was unchanged in August at an annual rate of 3.1%. If we look at the month on month move this is somewhat concerning as prices rose by 0.5% which compares with a month on month fall of 0.2% in July. Indeed further scanning of the detail of the statistical bulletin implies that we were close to a rise on an annual basis to 3.2%.
Although the 1-month movement was a 0.1 percentage point higher this year, the CPI 12-month rate in August 2010 remained at 3.1 per cent, the same as in July 2010 (the 0.1 percentage point difference is due to rounding).
What caused this?
There was upward price pressure from clothing and ,food and beverages (particularly wheat and cereal products for those following the developing “agflation” story). This offset overall falls in transport and fuel costs (air transport costs rose but other fell by more) and falls in the furniture,household equipment and maintenance section.
Perhaps the most interesting development has been that recent falls in the price of petrol and diesel were offset by price rises elsewhere. This has been a familiar trend in recent UK inflation experience as invariably any price falls seem to be offset by other categories.
Retail Price Index
Both main measures of the RPI fell from 4.8% to 4.7% and they mirrored each other because there was no particular change in mortgage rates which are excluded in RPIX our old inflatio targetn measure. Air transport and car purchase costs have different weights in the RPI as opposed to the CPI and it is these components and their different treatment which led to the recorded fall in the annual rate of inflation.
Comment and Analysis
These are poor figures for several reasons. Firstly we keep being told by the Monetary Policy Committee that price rises are “temporary” and yet we find inflation is still more than 1% over its official inflation target and more than 2% over its previous inflation target. The level of CPI inflation has been at least 1% over its official target for all of 2010 and the excuses we are given for this which in my view were never very strong (please see my articles on inflation from the beginning of 2010) are even weaker now.
There was some hope that this months figures might be an improvement based essentially on falling fuel prices but as I have pointed out above we seem to always have some inflationary pressure in our system. Indeed so-called core inflation, which excludes the cost of food, tobacco, alcohol and energy prices, accelerated to 2.8% from 2.6 % in July. Many economists use this as a sign of inflation to come and were expecting it to fall not rise. I have written before that there are bigger fans of the concept of core inflation than me as for a start its definition excludes food and energy which strike me as being somewhat vital, but the fact is that it appears to be rising again.
So our inflation problem in the UK is ongoing. This means in my view that the Monetary Policy Committee made a policy mistake,in my view, by not nudging interest rates higher at the turn of the year as I suggested at the time. I notice that one member of the MPC and four members of the so-called shadow MPC wish to raise interest-rates now. As there is a twelve to eighteen month lag in the main effects of an interest rate rise I fear that even if they should win the argument it will now be too late. This returns me to my earlier theme of central banks having more and more power and intervening ever more. If you look at their record this is a troubling development as they are far from being infallible and may well be a partial architect of our current problems rather than a solution to them.